David K.H. Begg, Gianluigi Vernasca-Economics-McGraw Hill Higher Education (2011)

Review questions
Review questions
c.onnect
An industry faces the demand curve:
1:
2 3 4 5 6 7 8 9 10
10 9 8 7 6 5 4 3 2
(a) Suppose it is a monopolist whose constant MC = 3: what price and output are chosen? (b) Now
suppose there are two firms, each with MC= AC = 3: what price and output maximize joint profits if
they collude? ( c) Why might each firm be tempted to cheat if it can avoid retaliation by the other?
2 With the above industry demand curve, two firms, A and Z, begin with half the market each when
charging the monopoly price. Z decides to cheat and believes A will stick to its old output level.
(a) Show the demand curve Z believes it faces. (b) What price and output would Z then choose?
3 Vehicle repairers sometimes suggest that mechanics should be licensed so that repairs are done
only by qualified people. Some economists argue that customers can always ask whether a mechanic
was trained at a reputable institution without needing to see any licence. (a) Evaluate the arguments
for and against licensing car mechanics. (b) Are the arguments the same for licensing doctors?
4 Think of five adverts on television. Is their function primarily informative, or to erect entry barriers
to the industry?
5 A good-natured parent knows that children sometimes need to be punished but also knows that,
when it comes to the crunch, the child will be let off with a warning. Can the parent undertake any
pre-commitment to make the threat of punishment credible?
6 True or false A firm in a monopolistically competitive market faces a downward-sloping demand
curve for its product.
7 Common fallacies Why are these statements wrong? (a) Competitive firms should get together
to restrict output and drive up the price. (b) Firms would not advertise unless they expected
advertising to increase sales.
8 Consider a market with two firms, 1 and 2, producing a homogeneous good. The market demand
is P= 130- 2(Q1 + Q2), where Q1 is the quantity produced by firm 1 and Q2 is the quantity produced
by firm 2. The total cost of firm 1 is TC1 = 1 OQ1, the one of firm 2 is TC2 = 1 OQ2• Therefore, we have
that MC1 = 10 and MC2 = 10. The marginal revenue of firm 1 is MR1 = 130 - 4Q1 - 2Q2, while the
marginal revenue of firm 2 is MR2 = 130 - 2Q1 - 4Q2• Each firm chooses its quantity to maximize
profits.
(a) From the condition MR1 =MCI> find the reaction function of firm l, and from MR2 = MC2, find
the reaction function of firm 2.
(b) Find the equilibrium quantity produced by each firm by solving the system of the two reaction
functions you found in (a). Sketch your solution graphically.
(c) Find the equilibrium price. Find the profits of each firm.
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